8 Sources of the U.S Financial Crisis – How it all began.

How this economic crisis that began in the United States, and how did it happened? Between all the information being distribute around, on the  easy to find among all the information gleaned on the left and right on the subject. Yet, as a real estate professional, you certainly raise questions about this, as we pose to ourselves.

Peter Langlois, senior economist at The Federation of Chambers of Quebec real estate (FCIQ) focused on the subject, and wrote in late October, an explanatory document, simple and easy to understand, in order to educate ourselves on the importance of this financial crisis. You will find below the summary.

“What is spectacular with the current crisis is the extent of penetration of mortgage tools in the financial system,” he wrote. The sources of U.S. financial troubles are many, but “can be grouped under eight chapters, eight arms of a “financial octopus” eventually stifled some of the jewels of Wall Street”.

To understand what is happening now, it is important to consider other financial crises in the past:
American Savings and Loans (1989-91)
Swedish crisis (1992)
Asian crisis (1997)
Argentine crisis (2001-02).
Desjardins has also published an analysis on the crises of the past 30 years.

For P. Langlois, reflected common signs of these crises, including: real estate speculation, deregulation, debt of the public sector and the drop in local currency … All symptoms showed by the U.S. economy before the current financial crisis.

8 Sources of the U.S Financial Crisis

1. Real estate speculation and deflation of the bubble

Several U.S. real estate markets have experienced dizzying price increases between 1998 and 2005, including Florida, Nevada, New York, Arizona and California. Manufacturers have increased housing starts … until there was a surplus of inventory. It followed a downward spiral on prices, higher interest rates and defaulting owners tied to variable mortgages.

When we talk about real estate speculation, we believe, among others, about Flipping. Nearly 40% of residential transactions in the United States did not acquire a main property (residence). This has been encouraged by several authors and TV shows such as “Flip this House”, for example.

2. Subprime mortgages and mortgage brokerage

The proliferation of subprime mortgages is at the heart of the crash of the U.S. financial sector. From 1994 to 2006, the share of these “tools” increased from 5% to 20%. One of the subprime instruments was the most popular ARM (interest-only adjustable rate mortgage). A formula which allowed to pay only interest, and no capital … for a while!

U.S. mortgage brokers are also covered in the study of sources of the current financial crisis. How? It is suggested that the products to customers were in some cases depending on the premium payment received by the broker.

3. Credit Ratings

The rating agencies credit the 3rd source of this mortgage crisis. Giving ratings to inappropriate financial structures backed by pools of mortgages as collateral, the agencies have fooled many institutional investors.

4. A complex financial science and incompetent government

The structure of financial instruments has become very complex. The leaders of institutions and boards are currently suspected of incompetence, by their ignorance of the risk factors involved in their investment process. The structure of the remuneration of such leaders would also be a source of the current crisis.

5. Monetary policy and government policy

Both policies are identified: the monetary policy of Alan Greenspan and the policy of Housing and Urban Development Department (HUD).

6. The behavior of the American consumer

The U.S. consumer is also a source of the crisis, because of its lack of vision, responsibility and the use of credit feverish. In 2004, the U.S. Fed estimated the total debt of U.S. consumers more than 2 trillion (2000 billion) dollars, excluding mortgages. Simply by debts of credit cards, the average American was (before the crisis!) an estimated $ 9,000 and $13,000 in debt.

7. The Absence of Financial regulations

According to estimates made in 2004 by a former Fed governor of the U.S., over 50% of subprime loans were made without any guidance from the federal government. These loans were also accompanied by heavy financial penalties linking consumers … and they addressed to those who were less equipped to understand the impacts of such financial arrangements.

8. Financial Lobbying

How the U.S. Congress he could leave the financial sector without a regulatory framework? Part of the answer could be the links between the industry and finance electoral campaigns of U.S. legislators.

And in Canada?

An analysis on the sources of the American crisis would be complete without a parallel with what is happening in Canada.

First mention that according to Peter Langlois, 3 of 8 sources of the crisis are minimally on Canadian soil.

Canada has a stricter professional supervision with regard to real estate brokerage and mortgage brokerage.

The mortage options are less exotic in Canada. The subprimes are marked by CMHC and other mortgage insurers.

Regarding the funding of political parties, Canadian regulations prohibit payments from the private sector (since the sponsorship scandal in 2004).

However, the listing of credit in Canada is done by the same players as in the USA and the governance of financial institutions is not very different from our southern neighbors. The Bank of Canada, by its size and volatility of a small currency like the Canadian dollar continues to lose its independence from major central banks. Finally the discussion launched by Ottawa on possible centralization of regulatory powers could be positive in a context where the financial framework, shared between the provinces and the federal government increases the risk of regulatory vacuum on certain financial products or distribution of those thereof.

“Canada must learn from the U.S. troubles and carefully revise its financial regulation, both in the banking industry, securities as  well as their distribution,” the report concludes with this analysis of Peter Langlois, an economist, Federation of Chambers of real estate Quebec.

To view the original document, a link on the Blog of College Immobilier du Quebec can be found here

Feel free to leave your comments and thoughts on this subject.
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Posted by:  Deya Bautista - Real Estate Broker working as part of the McGill Immobilier team. Specializing in high end condos in downtown and Old Montreal. For buying or selling contact Deya at: 514.917.7889

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